Question

Company BM pays quarterly dividends. As of the 20th of Feb 2019, the dividend of 20 cents was just paid today and the next will be paid 1 quarter later. Suppose future dividends will be growing at 2% per quarter forever. We require 15% return per year (EAR).

a) What is the intrinsic value of BM today?

b) One quarter later, you sell the BM stock at P/E ratio of 7. If BM’s earning per share is $2, what is the selling price

c) Suppose the value you get in part (a) is also the market price of BM by then, you sell it one quarter later at the price in part (b) before it pays dividend. What is

the holding period return from the 20th of Jan 2019 to 20th of Apr 2019?

d) You just inherited a trust that will pay you 126000 per year in perpetuity. The first payment occur in 5 years larer with a 9.32% annual interest rate, what is the value of the trust?

Answer 1

Given Data As per Question:

Dividend paid on 20th Feb 2019 (D0) =	20 cents
Growth (g = 2%) =	0.02
Return per year (r = 15%) =	0.15	Return per quarter = ((1+EAR)^(1/4)) - 1 =	0.0355581

One quarter Later:
Sell BM Stock at PE Ratio	7
BM's Earning per share	2

Payment to be made per year in perpetuity	126000
Annual Interest Rate (r=9.32%) =	0.0932

Therefore,

Answer(a)	Intrinsic Value =	((D0)*(1+g))/(r-g)
	BM's Intrinsic Value =	1311.216088 cents	$13.1122

Answer(b)

Selling price one quarter later =

((BM's EPS)*(1+g))*PE ratio

$14.28

Answer(c)	As per ques:
	BM's Market value	$13.11216088
	Selling price of BM one quarter later	$14.28
	HPR	(Ending Price-Beginning Price)/Beginning price	8.91%

Answer(d)	As per question, first payment on the perpetuity will be made 5 years later.
Therefore, Value of perpetuity instrument at the end of 4th Year	Payment to be made per year in perpetuity/ Annual Interest Rate	$1351931
Present value of Perpetuity	Value of perpetuity instrument at the end of 4th Year/(1+R)^4	$946577